More reasons to build a diversified stock portfolio.

I read this article on Motley Fool that reminds us just how important it is to diversify our investment portfolios. A pure U.S. stock portfolio will make you pretty vulnerable right now. Why? Because of the threat of inflation. And if it’s not that, you can also worry about deflation, which can also be devastating to your investments.

Here’s why inflation is so tough on our domestic equities. With costs for doing business rising across the board, it begins to put a damper on companies and their performance. That’s one way of looking at it. Another way to look at it is this: the stock market rises when it faces a recessionary environment and falls in a stronger economy. This is because the stock market looks ahead: during a slow economy, the market expects the Fed to take on an “easy credit” approach and will expand the money supply. When inflation is around, the Fed will instead control interest rates and the money supply, by tightening.

On this note, there’s an economics professor named Charles R. Nelson who’s come up with this interesting trading rule that is based on the relationship of the consumer price index and inflation:

“When CPI inflation is on the rise, stay out of stocks; when CPI inflation is on the decline, buy stocks.”

Now we’re actually facing the possibility of higher inflation in the near term. With a huge deficit and stimulus programs, TARP bailouts and massive government spending left and right, the expectation here is that we’ll be visited by inflation. If so, what can we do to protect our investments?

Go Beyond U.S. Stocks To Hedge Against Inflation

Don’t be 100% invested in U.S. stocks if that’s the case. Go beyond our domestic stock market for some protection. Some ideas include investing some of your funds in iBonds, TIPs, commodities and foreign equities. You can also invest in foreign currency through a bank like EverBank, which offers foreign currency products (particularly certificates of deposit).

It’s always a good idea to be diversified anyway — and it’s obvious why. As investors, we’re always facing different conditions brought about by changes to various aspects of the economy. Our portfolio may be right for one set of conditions, but may be unable to weather other economic and financial scenarios. It is therefore imperative for us to keep up with the signals put forth by economic indicators and perhaps to do what is necessary to build an all-weather investment portfolio.

Go Beyond U.S. Stocks To Hedge Against Inflation is a post from: Investing Toolkit

We’ve explored day trading vs long term investing before. Let’s now take a closer look at stock market timing.

Market timing is a strategy that people use to determine when to stay or leave the market, or when to buy and sell their positions in a particular asset class. Active traders try to make money by predicting future moves in the market. Whether or not they’re successful at this depends on their skill, luck and experience.

So why do people day trade or perform market timing? Different investors and traders time the market for various reasons. For some, it’s because they believe that they can beat out average stock market returns, which typically range between 8% to 10% annually over the long term. For others, it’s because they want to protect their positions and reduce risks to their portfolio. And for many others, it’s all of the above!

I’ve seen all kinds of market timing over the years. While many people use online stock trading tools, trade on a daily basis and make high volume trades with small gains per trade, others use a different strategy and simply trade occasionally: their time between trades is long and they time the market as more of a long term strategy. If they sense the market shifting away from its long term trend, they may make a move to either buy or sell.

The Pros of Stock Market Timing

It is imperative to note that trading the market isn’t for everyone. Most investors should stick to their long term investing strategy of investing in diversified funds and ETFs. Better yet, they should invest in index funds or ETFs. For those of you who insist on trading and who’ve studied a particular investment market well, you may want to try out trading by using a “fake portfolio” first, or by investing only a little of your money before you jump in with both feet first into this high risk activity.

If you begin trading without a plan, you’re simply gambling money away. You can always approach trading cautiously and build up your experience over time in order to increase your chances of doing well in the markets.

What are some of the pros of market timing? The main thing here is that by learning some amount of technical analysis, you can engage in some stock market timing in order to make money regardless of the direction the market takes. By following market trends, you can anticipate (using the statistically favorable outcome) what kind of move to make next: this means that you can go long or short and still make money no matter what the market does. If you can do this well, you’re ahead of long term investors who only make money when the market goes up.

Also, if you’re a good trader, you can hedge your portfolio well and manage your risks using market timing methods.

The Cons of Stock Market Timing

Long term investors will tell you that timing the market is an awful idea: that there are only “cons” to performing this activity, and that trading simply amounts to gambling. But I believe that there’s a place in the investment universe for trading — you just have to fit this type of activity by having the right profile and experience of a true trader.

Given this context, I believe that there are some disadvantages to timing the market. One is that you’ll rack up a lot of tax documentation by trading up a storm. You’ll have to account for each transaction you make and it can be a pain to do this if you’re not properly equipped with the right tools. A corollary to this matter is that you’ll have to keep good records in order to know just how well you’re doing and how much you’ll owe the government come tax time.

Finally, I’d say that the main drawback of trading is really inherent in how it works: in order to make money, you’ll have to be right twice — once when you buy and once when you sell. You’ll have to know when the right time is to jump in the market, and when the right time is to jump out. If you aren’t in the stock market during its biggest days (when it makes the greatest gains), you’ll be losing out on big investment returns and your returns over time will greatly suffer. Making such a mistake would spell disaster for your track record as an investor.

A word of advice: if you’re bent on stock market timing and active trading, make sure you do so with your head and not with your emotions. Emotional trading will only ruin your bottom line. Trade as part of a well thought out strategy and not as an impulsive reaction to market movements.

Pros and Cons of Stock Market Timing is a post from: Investing Toolkit

Watching my 401K balance continue to drop makes me sick to my stomach such that I’ve begun to consider trying my hand at timing the market. I’ve always had a bit of gambler’s blood in me and wonder if I could conceivably learn how to trade successfully without losing my shirt. No doubt, there are benefits and many pitfalls with day trading and market timing when compared against long term investing, but the ultimate goal is the same: to make money. So I’d like to take this opportunity to investigate these investment strategies to see what will ultimately make sense for anyone who’d like to make money in the market. How should I approach the stock market?

Day Trading vs Long Term Investing: Exploring Investment Strategies

The volatile nature and quick liquidity of buying and selling on the same day is what excites and appeals to most day traders. The thought of a quick substantial increase (in paper profits) is very tempting and gets the blood surging. I have to admit, this is something I’ve been toying with for a while, and the more I hear about forex trading, the more I’m intrigued. But our losses can materialize as easily and quickly as our profits, and if we don’t have a complete understanding of the market and its conditions, we can lose everything in an instant. Expecting to make money on every trade is unrealistic and we must fully understand what we are doing.

While the emotional part of myself is interested in the possibility of learning how to trade stocks and foreign currency, my sane self knows that this is something I should not take lightly. That’s because I understand that long-term investing is what makes sense to most of us, and frankly, it’s what I think that average investors should ONLY think of doing. Especially those young enough to be able to really see the rewards of their initial investment.

When I was younger, I had invested in a mutual fund. But it was something I did not hold on to for long. At some point, I sold my shares. Where is that money now? I couldn’t tell you, but I certainly enjoyed spending it. Even back then, I don’t think I really thought about the long haul: if I had not given into the desire to reap those short-term rewards — that is, if I had stayed in my fund for the long term — then I’d have an even larger nest egg than I do now. Of course, all of this is in hindsight, but anyone can see that slow and steady investing can get you pretty far. Whereas to even come close to winning any profits through trading, you’d have to trade with enough funds and volume to make it worth your while. The risk of approaching the market as a day trader would be significant if you have no experience or skills in this area (which is the case for most who try their hand at this).

Investing Throughout History

The 90’s, the age of the dot comers, will go down in the history books forever. The instant boom in certain stocks caused chaotic behavior, with many people making money hand over fist. The boom didn’t last long and it caused an economic crisis, but gave birth to a whole new way of investing. Day trading is the legacy of that gilded age.

Today, the stock market investing climate is wholly different but the market will always remain a place of risk. No one can really predict what’s going to happen to our investments in the long term (although there’s a good chance that the trend will continue its upward march). Even solid and stable companies can go under during hard economic times. The collective mood of investors these days has been dour, as they watch their portfolios stagnate in the limbo brought about by our economic recession. But many others also see this as a great opportunity to buy low and leverage the stock market at its weakest point.

How To Approach Day Trading and Long Term Investing

While I believe that 95% of investors should really just stick to long term investing by learning how to invest in index funds, employing dollar cost averaging and seeking a good mutual fund, I can also understand how stock trading can make sense for a small segment of the investing population. Conventional wisdom reminds us that long term investing makes the best sense for our portfolios as it increases our chances of actually making money if we stick to the program. It is much much trickier to make money with day trading and market timing strategies since it will involve a lot of knowledge, experience, skill, luck and active work to have a chance at being successful in this endeavor. If we apply prudent risk management here, then it makes sense to involve only a small portion of our assets to this cause, if at all. Another option is to join fantasy trading (or virtual trading) platforms where we can have fun trading with fake money and a practice portfolio.

Okay maybe I’ve somehow convinced myself to just try out those online virtual stock trading games for now.

Day Trading vs Long Term Investing: Exploring Investment Strategies is a post from: Investing Toolkit

The vast majority of investors have their stocks, bonds, and mutual funds through their brokerage accounts. What this means is that the stock broker actually holds assets in behalf of their clients and retains these assets in clients’ accounts. If a broker is not a member of the SIPC (also known as the Securities Investor Protection Corporation), there is virtually no protection in the event that the brokerage goes bankrupt. However, most legitimate brokerage firms are members.

The SIPC is not an agency of the federal government, but a member agency. This means that member brokers pay into it. You will know that a brokerage is a member because all of its signage and ads will include the words, “Member SIPC”. Should there ever be any doubt, you can contact the SIPC by phone or on the web to verify your broker’s membership. Although the SIPC does not guarantee your investment’s value, they will give you some assurance against losing property.

How The SIPC Protects Investors

The SIPC helps most customers of failed brokerage firms who’ve discovered that their assets are missing from their accounts as a direct result of the bankruptcy. The goal here is for clients to recover their missing stocks and bonds, regardless of their actual value. In other words, the number of shares owned will be returned to the customer without respect to the dollar value. But be aware that futures commodities, cash, and investment contracts that are not registered with the U.S. Securities and Exchange Commission are not protected by the SIPC.

What Happens If Your Broker Faces Bankruptcy?

When an investment brokerage fails, there are several steps that someone needs to go through in order to recover missing assets as per SIPC regulations. The goal of the SIPC is to restore assets and securities to their rightful owners. We’ll give you the highlights:

1. Customers will ultimately get back the stocks and bonds already registered in their name or in the process of being registered.

2. The brokerage firm’s remaining customer assets are divided and divvied up proportionately, based on the size of customer claims.

3. No more than $500,000 per customer, including a maximum of $100,000 for cash claims, will be honored. This is the SIPC cap.

4. Once the brokerage is liquidated and appropriate SIPC compensation is provided to the broker’s clients, it is possible that the bankrupted company may still have leftover assets. If so, these funds are used to satisfy any remaining customer claims above the SIPC cap.

5. The value of recovered securities is not guaranteed to be the same as it used to be, due to fluctuations in the markets.

Customers can expect to receive their property back in about one to three months. If a brokerage keeps good records, it’s possible for assets to be received shortly after the claim is filed. Unfortunately, delays of several months happen when records are not accurate or when the principals are involved in fraud. Still… if I were in this situation, I wouldn’t mind the wait if I can be assured of getting my assets back! I’m just glad we have the SIPC, because without it, investors who are victims of broker bankruptcy would just be out the money!

How The SIPC Protects Investors From Broker Bankruptcy is a post from: Investing Toolkit

There are lots of uncertainties we face in this world, including the danger of losing our money in ventures that carry some amount of risk. Anyone who’s considered trading and investing in the markets should carefully assess the risks involved with putting one’s money on the line. Achieving investment goals and minimizing your risk of a loss are not necessarily mutually exclusive events — these are not impossible to accomplish, but it all depends on a number of key factors.

What Kind of Investment Risks Should We Be Aware Of?

1. The Economic and Political Climate. The uncertainties that we experience in the current economic climate are often a major factor in how we should be investing our money. Interest rates, inflation, recession, and war can influence our decisions and are some of the things we should consider when making an investment. As stock prices fall and the economy continues to stall, so does our desire to take a chance on investing in the market.

2. Business Conditions. Whether or not you’re buying or selling stocks or participating in Forex trading, you will want to analyze and think about the financial condition of the business or country you’re investing in. When buying stock, you’re considering the” long haul” outcome. But you still want to keep track of the market and business conditions that the company you’re investing in is facing. A slow down in corporate activity could indicate a reason to sell to prevent a substantial risk of losing a good amount of money. In a short-term trade, certain conditions surrounding an investment can change in a matter of days, even hours, so day traders are constantly keeping track of market data and market activity to avoid a possible loss.

3. A Down Market. While some investors cringe at the mere mention of a “down” market, others look at it as an opportunity to invest at a good price. Take the housing market for instance. Three years ago prices were going through the roof, and now, we’re seeing a complete reverse in housing price movements. People are now watching the value of their homes slip and seeing neighborhoods disappear or fall into foreclosure. But there’s a new wave of investors who are taking advantage of the slumping housing market and buying up all the property they can afford. They know that if they hold long enough, they will eventually make a profit on their investment. On a similar note, a savvy stock investor who’s able to buy low and leverage the stock market can make a substantial return in this down market, if they have the resources and knowledge to participate in it.

4. Risk Management. While there’s no questioning the benefits of experience in any business venture, establishing a risk management program is a vital part of success. You can open yourself to a tremendous amount of risk if you’re not careful and do not understand the complexities of investing in the market. You need to find your comfort level and what you are willing to risk, because there’s always some amount of danger in buying stocks and bonds, and trading in the foreign exchange market. But if you do your research and consult with experts whom you trust will help you develop a sound investment plan, you will minimize your risks and have the potential of reaching your profit goals.

Facing Investment Risks: Watch Your Money! is a post from: Investing Toolkit

With the economy in an upheaval and the general public terrified of the recently collapsed stock market, fewer people are investing. A lot of people who were investing have taken their money and put it in the safest, lowest yield investments they can possibly find. Many of them are simply sitting on cash.

Invest in a Deflated Market!

Smart investors know that this is the time to invest. Why would anyone invest when the market is at a serious low? That’s exactly the reason. The market has almost no place to go but up! Since most investors have and still are fleeing fast, current investors can buy at great prices and expect an even greater return down the road.

Buy Low To Leverage The Stock Market

The history of the stock market is fraught with numerous serious downturns. These have usually been followed by tremendous upswings. The upswing is the great return and reward for those who invested during the serious downturns. Take a look at this historical chart for the Dow Jones Index (DJIA: 1900 – 2009), which shows that the long term trend of the U.S. market has been UP.

Dow Jones Index Historical Chart: 1900 – 2009

Now of course, there are still risks we face when investing in any market. Just check out the long term trend of the Nikkei Index (which has been volatile). The key therefore, is to be prudent about how you invest, and not to put all your eggs in one basket.

Nikkei Index Historical Chart: 1985 – 2005

So exactly when will our economy bounce back? No one can predict the answer with any kind of accuracy, but there can be no reward without investment.

What to Invest in?

Now the question here is: which stock or investment is a winner? Which one will give investors the biggest return and set them financially free for the remainder of their lives? The key is to diversify. As with the timing of the economic recovery, no one can predict with 100% accuracy which stocks will be the biggest winners. If that was the case, it wouldn’t be called “playing the stock market”. However, by investing in a number of stocks and different asset classes, you reduce your risk of loss and increase your chance of success. Some quick, common sense tips for investing success:

• Use caution and seek the financial counsel of those in the know — unless you are confident that YOU are in the know.
• Never take advice blindly.
• Personally confirm the expert advice that you’ve obtained by researching investments.
• If you encounter any red flags during your own research, don’t hesitate to express your concerns to your expert counselor.
• Do not sink your money into an investment until your concerns are alleviated and you have confidence that it holds the risk and return potential that you expect.
• Best of all, learn about investing as much as you can.

Buying stocks when everyone else is skittish is not a bad idea. In fact, the deflated economy offers wonderful opportunities to reap a bountiful harvest to those who are willing to weather the storm for a little while. The stock market’s track record indicates that what goes down will eventually go up. Prepare for your harvest today!

 
Image credit: Pattern Spy

Buy Low And Leverage The Stock Market is a post from: Investing Toolkit